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China's Currency Going Global with CNH

China is eager to
successfully "internationalize" its currency, as it looks to further promote
international trade and associated trade settlement. But as always, it will
proceed on its own terms despite global demand for change. As was the case last
year, 2011 trends continue to indicate slow, anemic economic recoveries in the
West and strong economic activity in the Pan-Asia region. China is again
expected to lead the way via its robust economic engine and to achieve
double-digit growth by year end. Its healthy domestic economy (3rd largest
globally), strong foreign trade (2nd largest), and focused central government
with deep financial pockets (largest single holder of U.S. debt), enables China
to make aggressive, forward-thinking policy changes as it attempts to morph into
a true global player. Beyond last year's resumption of its politically charged,
managed-float currency policies, and its controlled stair-step appreciation,
China has aggressively moved forward with its efforts to also liberalize its
domestic currency into what many believe could one day be considered a true
global reserve currency alongside the U.S. dollar.

Some Background on
the Currency

The Renminbi (RMB), literally translated as "people's
currency," is
the official currency of the People's Republic of China (PRC), whose principal
unit is the yuan, commonly abbreviated as CNY. The currency is the official
legal tender in Mainland China, but not in Hong Kong or Macau. Historically it
has served as a domestic currency, is highly regulated within China, and hasn't
been allowed to freely float in the global currency markets.

Because of
its highly restrictive nature, mainland (onshore) CNY activities (foreign
exchange, domestic/international payments, and various global trade flows) have
been closely monitored by China's Central Bank, the People's Bank of China
(PBoC), forcing global transactions (offshore) to be limited in scope and
somewhat disconnected from onshore markets.

Given China's supportive
economic background, the focal reason CNY isn't already a reserve currency
centers around the deliberate choice by the Chinese government to resist freely
floating its currency and not allowing seamless convertibility. Traditionally,
onshore conversion of incoming FX flows into CNY for trade purposes have been
somewhat available since the mid-1990s, but most financial account transactions
are either banned or highly restricted by the PBoC. Access to onshore financial
markets has also been very limited for offshore entities, forcing local
exporters to invoice in USD and locally convert those dollar payments with
PBoC-approved banks. Foreign investment flows have also been highly regulated
and controlled, allowing only a small number of qualified institutions to invest
in higher-yielding, CNY-denominated assets, with the effect of limiting the
depth of China's onshore bond and money markets.

High Demand for
Offshore CNH

As the first step to make yuan fully convertible and to
further improve China's international trade flows, the Chinese government last
year chose to take a very localized and measured approach by creating an
offshore currency market in Hong Kong, identified as CNH. This new currency will
ultimately enable two-way FX conversions for ongoing Hong Kong-only based
transactions, and won't be subject to current onshore CNY-based restrictions.

While this new offshore market continues to evolve, initial cross-border
settlements via CNH to/from the mainland are currently available, but restricted
to the pre-approved PBoC Mainland Designated Enterprises (MDE) list of local
importers and exporters. As of December 2010, the MDE list was estimated to be
nearly 70,000 from an initial count of 365 just a few months prior, illustrating
the immediate high demand for this new financial instrument. While local
importers and exporters are required to adhere to ongoing MDE guidelines,
they're now very encouraged with this newly available local pricing vehicle as
they transact with their offshore customers.

FX liquidity in this newly
formed offshore currency market is also growing beyond initial expectations. The
PBoC revealed last month that the offshore volume of CNH transactions reached
the equivalent of CNY 340 billion from June to November. Most of the elevated
volume centers on onshore importers holding deposits ahead of their anticipated
USD purchases and corresponding payments. This activity is very supportive for
the CNH Chinese bond market, as deposits in 2011 are expected to double from
last year record levels.

What to Expect Going Forward

The Q4
2010 ramped demand for convertible CNH is expected to aggressively grow in 2011.
The official MDE list should continue to expand and PBoC policy and regulations
surrounding offshore CNH activity will also continue to evolve as
offshore/onshore cross-border activity converges and eventually becomes
seamless. As the CNH financial markets grow broader and deeper, China will
ultimately be perceived as a legitimate alternative in the international
investment community. On the currency side, the ability to trade, invoice and
settle currency outside the mainland will enable offshore corporate and
institutions to buy, sell, invest and actively hedge their exposures using CNH
products like any other G-20 currency.

Next week in this column, my
colleague Fernand Kong will address the various corporate implications that the
newly convertible CNH will present to offshore entities.

The views expressed in this column are solely
those of the author and do not reflect the views of SVB Financial Group,
or Silicon Valley Bank, or any of its affiliates. This material,
including without limitation the statistical information herein, is
provided for informational purposes only. The material is based in part
upon information from third-party sources that we believe to be
reliable, but which has not been independently verified by us and, as
such, we do not represent that the information is accurate or complete.
The information should not be viewed as tax, investment, legal or other
advice nor is it to be relied on in making an investment or other
decisions. You should obtain relevant and specific professional advice
before making any investment decision. Nothing relating to the material
should be construed as a solicitation or offer, or recommendation, to
acquire or dispose of any investment or to engage in any other
transaction.

Foreign exchange transactions can be highly risky,
and losses may occur in short periods of time if there is an adverse
movement of exchange rates. Exchange rates can be highly volatile and
are impacted by numerous economic, political and social factors, as well
as supply and demand and governmental intervention, control and
adjustments. Investments in financial instruments carry significant
risk, including the possible loss of the principal amount invested.
Before entering any foreign exchange transaction, you should obtain
advice from your own tax, financial, legal and other advisors, and only
make investment decisions on the basis of your own objectives,
experience and resources.

China is eager to successfully "internationalize" its currency, as it looks to further promote international trade and associated trade settlement. But as always, it will proceed on its own terms despite global demand for change. As was the case last year, 2011 trends continue to indicate slow, anemic economic recoveries in the West and strong economic activity in the Pan-Asia region. China is again expected to lead the way via its robust economic engine and to achieve double-digit growth by year end. Its healthy domestic economy (3rd largest globally), strong foreign trade (2nd largest), and focused central government with deep financial pockets (largest single holder of U.S. debt), enables China to make aggressive, forward-thinking policy changes as it attempts to morph into a true global player. Beyond last year's resumption of its politically charged, managed-float currency policies, and its controlled stair-step appreciation, China has aggressively moved forward with its efforts to also liberalize its domestic currency into what many believe could one day be considered a true global reserve currency alongside the U.S. dollar.

Some Background on the Currency

The Renminbi (RMB), literally translated as "people's currency," is the official currency of the People's Republic of China (PRC), whose principal unit is the yuan, commonly abbreviated as CNY. The currency is the official legal tender in Mainland China, but not in Hong Kong or Macau. Historically it has served as a domestic currency, is highly regulated within China, and hasn't been allowed to freely float in the global currency markets.

Because of its highly restrictive nature, mainland (onshore) CNY activities (foreign exchange, domestic/international payments, and various global trade flows) have been closely monitored by China's Central Bank, the People's Bank of China (PBoC), forcing global transactions (offshore) to be limited in scope and somewhat disconnected from onshore markets.

Given China's supportive economic background, the focal reason CNY isn't already a reserve currency centers around the deliberate choice by the Chinese government to resist...Read More

Policy

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